Every time an investor invests money into a company, or into a syndication or into a fund or something, any kind of vehicle where they’re looking to make money, but be a passive investor, so not do the work themselves rely on a syndicator, a manager, a sponsor, something like that, that automatically is a security. When something is a security, it must either be registered with the SEC, the Securities and Exchange Commission, or fall under an exemption. This video is going to go through what those exemptions are that syndication attorneys look to when they have a client who is a syndicator, or an investment fund looking to put an offering out and raise money from investors.
So what are those exemptions, exemptions to registration? Well, first, let’s talk real quickly about what registration is. Registration really means going public, right. So it means getting a whole group of attorneys together, to pour over formation documents, getting accountants to gather, getting underwriters together, it’s extraordinarily expensive. It takes an extraordinary amount of time. Why? Because the SEC’s role is to protect investors from getting basically defrauded out of their good hard-earned money into things that may not be that great to invest into. So the underwriting process and the review process of a registered security is very, very strict.
Now, if it is a private offering, then that falls under the exemption. So the exemptions ultimately are where the SEC has said, “Look, we know that you can make private offerings, once that thing is a private offering, we’re going to regulate it. But we’re not going to regulate it as closely as a public offering where the entire public could be exposed to potential fraudulent behavior.” So it’s still regulated, but less so.
So what are those exemptions? Like I said, we’re going to talk about five different exemptions that exist. Chief and foremost, number one exemption of all time is Regulation D. Somewhere between 95 and 98% of all private offerings that exist fall under Regulation D. It is a very, very well constructed, very workable system to put a private offering out there.
Now there are two primary rules that we look to about the offering. That’s rule 506(b) and rule 506(c). Under Rule 506(b), you can raise an unlimited amount of money from an unlimited amount of accredited investors and up to 35 non-accredited investors in any 90-day period. I have another video for that. We’ll link that up in the notes.
Also available is Regulation D rule 506(c). Rule 506(c) is similar. You can raise an unlimited amount of money from an unlimited amount of accredited investors, but no non-accredited investors. So what do you get for this? Well, you get the ability to make a general solicitation, you get to advertise that security that’s out there to the general public so that people can invest. But you got to make sure that every single one of those investors is an accredited investor. So that normally comes by third-party verification of their accredited investor status. Once somebody is an accredited investor, they’re able to invest.
So those are the two main rules of Regulation D: rule 506(b) and rule 506(c). I will mention there is also Regulation D rule 504. Some of your old school people may be familiar with this because it was very common until Regulation D rule 506(c) came out. 506(c) lets them advertise; 504 kind of let you advertise. The big problem with Regulation D rule 504 is that it had to have review of every blue sky filing that would need to take place. So every state’s blue sky laws needed to be reviewed and analyzed to make sure that it was compliant. This obviously caused a huge amount of overflow and attorney time, making the cost very prohibitive.
So that’s where Regulation D rule 506(c) was basically born out of that. And under 506(b) and 506(c), Congress has basically said, “Okay, look, under these rules, we’re going to allow this investment to take place, we’re going to let these investments take place under there, and we’re going to preempt all the other states.” So it basically states, the state review is allowed. So states still have the right to request to be notified about them. But they no longer can say that they get to be the decision maker, or that State Blue Sky laws themselves are applicable to the actual nuances of it. So they can’t determine who can buy and sell. They can’t determine what different rules regulated itself, those now are preempted under rules 506(b) and 506(c). This is important because it comes back again later.
So that’s rule number one. The first number one exemption is Regulation D. Another common exemption, much less common, probably the third most common is Regulation CF for regulation crowdfunding. Regulation crowdfunding is a good rule, its limits have now been raised. So somebody can raise up to $5 million using it. The problem is that all the transactions themselves need to go through what’s called a registered portal. So if you think of like Kickstarter, or things like that, where people are making investments into something, which really is a security, and they’re looking maybe to make a profit, but what they ultimately are getting is some chunk of that profit, and it can be advertised, but everything needs to take place through that registered portal.
Now the registered portal is registered with FINRA, it complies with the rules of the SEC. And it is heavily regulated itself. And it’s acting as the guardsman to make sure that people are not being hoodwinked and taken into fraudulent investments. Because ultimately, that registered portal is now kind of acting as a Guardsman making sure that the offerings are somewhat coherent, and that they have protections in place for those investors.
Probably the second most common exemption is Regulation A. Regulation A has two parts, tier one and tier two. What’s important about Regulation A is that it actually is kind of like a public offering. So you can have investors invest into these Regulation A tier one or tier two offerings. And those investors don’t need to be accredited; they can invest as non-accredited investors. The challenge that I’ve found as a syndication attorney with Regulation A is that it takes an extraordinary amount of time and an extraordinary amount of money to put this together.
Now, why does it take so long, and why does it cost so much? Because essentially, the SEC still reviews these. It’s not a registration, but it’s close. What happens there is an SEC attorney will review it, make sure it complies with the rules of disclosure that need to be there, make sure that the Form 1-A, which is the form that it’s ultimately submitted on, discloses everything and makes very detailed financial disclosures. And all those disclosures that need to take place are not only expensive, but because they’re under the review of the SEC, there’s a lot of going back and forth time between attorneys, accountants, and the SEC, in order to make this thing valid. Average length of time a Regulation A offering takes is between six months and nine months. And the cost in attorney fees is generally over $100,000 just in attorney fees. And that’s not accounting for accounting fees, which are on top of that.
So those are three of the exemptions. The fourth exemption is one that you’re probably not going to use. It’s known as Section 3(a)(11). This exemption basically says that intrastate offerings are fine. So because we have this securities exemption that says okay, everything is either a security and must be registered or fall under an exemption. Well, what about those offerings that are just within one state where the sponsor has decided, “You know, I’m in state X, I want to make all of my rules under the State Blue Sky laws of state X, and I want to kowtow, everybody’s coming from there.” So everything is within that state. The SEC already has a rule just saying, “Hey, look, if it’s a 3(a)(11) offering, it’s an intrastate offering, it’s not our thing.”
The last one is kind of like a big coverall. And that’s Section 4(a)(2). Section 4(a)(2) offerings basically are saying, “Hey, there are exemptions to the SEC registration requirement.” So you could think of it as the chapter heading for Regulation D, Regulation CF, Regulation A, and even 3(a)(11). Because Section 4(a)(2) says, “Look, we’ve got these exemptions, they exist.” If it doesn’t fall under Regulation D, CF, A, 3(a)(11), what would happen is an attorney, if they needed to, would argue, “Well, it falls under the exemption of 4(a)(2).” 4(a)(2) is not a safe place to be for you, though. So keep that in mind, don’t start thinking that, “Well, I don’t need to follow the rules of Regulation D because there’s that Section 4(a)(2),” because 4(a)(2) is fraught with mine holes and potholes and things that are difficult, where basically, you can fall out almost immediately, mostly by not complying with the dollar amounts, by not complying with the review amounts, making sure that all this indicators are covered. It would essentially be like saying, “Okay, I need to comply with every single state rule that ever received marketing material on this.” So if all my investors are from all 50 states, I’d have to comply with every single state blue sky filing for all 50 states. Very, very complicated to do.
So those are the main five regulations, the exemptions that fall under the exemptions from the registration requirements. As a syndication attorney, what I do is I help syndicators decide for themselves what is the best mechanism for them to go forward. Almost always, the answer is Regulation D, because Regulation D is so good and is so useful. And the rules are so straightforward. And it’s just such a perfect, safe harbor for sponsors, that it’s almost always the right choice. Every now and then there will be something like, “Well, that really should fall under Regulation CF or Regulation A or even Section 3(a)(11).” So my job is to help sponsors find their right calling, go into the right place that’s there.
If I can help you with that, I’d be happy to have a conversation. The answer probably, though, I’ll give you a heads up, is probably going to be Regulation D. But what I do as a law firm is not only make sure that you’re falling into the right exemption from filing, but also make sure that you’re compliant and that you can follow through. You’re not going to be at risk and lose everything by being outside of one of these exemptions. So we prepare packages, prepare the private placement memorandum, operating agreement, subscription agreement, notify the SEC, notify the states, as well as just consult to make sure that our syndicators, my clients, are as successful as possible. Basically to take them from where they are today to where they want to go tomorrow. If we can help you, give us a call. We’d be happy to help.